Fundamentals of Technical Analysis: Continuation Patterns

The main goal of analyzing a financial security with technical analysis is to find trends in the security’s past and current price and volume data.  The easiest way to see these trends or patterns, which will be used to forecast future price movements, is to look at the data on a chart.  There are two main types of patterns, reversal patterns and continuation patters.  Knowing the difference between these will be helpful if you want to invest on your own, or are studying for any section of the CFA exams.  This article will discuss continuation patterns.  Remember, if there is no clear trend before the suspected pattern starts, the pattern has no predictive value.  Also, one challenge of technical analysis is that analysts cannot be sure of which pattern will form until after the fact.

Continuation patterns are patterns on a chart that suggest a previous trend will exhibit temporary changes, but will eventually continue that previous trend in the long run.  These are the opposite of reversal patterns which suggest that a previous trend will end and reverse.

Triangles

Two types of triangle patterns that form are ascending triangles and descending triangles. In an ascending triangle pattern, a horizontal trend line can be drawn connecting several highs that occur at the same price level.  This almost looks like a triple top trend line however instead of returning to roughly the same trough, higher lows form.  An additional trend line can be drawn connecting the lows which will have a positive slope.  The reason that this type of trend line forms is because market participants are selling the underlying stock at the same price level over a period of time. Buyers then purchase the stock at increasingly higher prices because they are feeling bullish.  In a descending triangle pattern, a horizontal trend line can be formed from several low prices, and almost looks like a triple bottom trend line, but instead of returning to the same high, this trend forms new lower highs.  The reason this trend line forms is because the demand of the asset is weakening, which is a bearish signal.

Rectangle Patterns

Another shape that continuation patterns can form are rectangles.  Depending on the prior trend the rectangle pattern can either be a bullish or bearish signal.  Ideally, the prior trend should be occurring for at least several months.  If they go on for longer than that, the chance that the pattern is a continuation pattern decreases.  Both the bullish and bearish rectangle are formed by two parallel trend lines: one connects the high prices of the pattern and one connects the low prices of the pattern.  The horizontal line forming at the top of the rectangle shows that traders are selling at a specific price which brings the price rally to an end.  Conversely, the horizontal support line forming at the bottom of the rectangle indicates that traders are making large enough purchases to reverse the declining price level.

Summary

Continuation patterns show technical analysts that a trend in a security’s price/volume data will continue. There are several different continuation patterns that are important to understand if you are in the investing field or are studying for any of the CFA exams. These patterns, including ascending and descending triangles, and bullish and bearish rectangles, are all signs that a current trend should continue in the future.